A Pro-Bailout Win In Greece Will Result In A Relief Rally. PIIGS Yields Will Decline

June 14, 2012

Yesterday, stocks retreated on European credit concerns. Greece will hold elections on Sunday and the race is tight. Pro-bailout candidates are expected to win by a slight margin. If this comes to pass, we will get a relief rally Monday.

In a recent poll in Greece, 80% of the people wanted to stay in the EU. Analysts are projecting a 2% margin of victory for the New Democracy. As long as a default is avoided, Asset Managers will have more clarity and they will buy stocks.

Spain secured its bank bailout and the focus immediately shifted to Italy. Interest rates spiked to their highest level this year. Overnight, Italy held a bond auction and yields are up 11 basis points. The bid to cover was 1.6 and that was a little light. I believe interest rates in Spain and Italy will pull back on a pro-bailout victory in Greece.

Traders will error on the side of caution. They know that if leftists win the election, PIIGS yields will spike and the market will tank.

A favorable election outcome would set the table for a nice rally. The ECB has injected $1 trillion into European banks, the IMF has more than $1 trillion in its coffers (trying to secure another $400 billion) and Spanish banks just received $125 billion. These reserves should temporarily restore confidence and instead of dragging out the negotiations in Spain, the EU took decisive action.

China’s economic growth is slowing, but their government has been proactive. They have lowered bank reserve requirements, reduced interest rates and they will spend money on infrastructure. All of these actions will stimulate activity and traders will look past the current “soft patch” (flash PMIs Wednesday night).

Domestic economic releases have been soft, but they are not dire. Initial jobless claims inched higher this week (6,000) and retail sales were down .2%. On a positive note, CPI and PPI declined. Energy prices are falling and that will have a positive impact on discretionary spending. Tomorrow Empire Manufacturing and industrial production will be released. These numbers will come in a bit light, but they won’t have a material market impact.

Next week, housing starts, FOMC, initial claims, the Philly Fed and LEI will be released. Traders are expecting to hear that QE3 is being considered and they are setting themselves up for disappointment. The Fed will not fire this last bullet until conditions are dire.

Greek citizens might be frustrated with the current austerity commitments, but they will vote for pro-bailout candidates. They do not want to get booted out of the EU. This “market friendly” outcome will lead to a rally.

Obviously, I am betting on the election outcome. If I am wrong, the market will tank and I will pay the price. Consequently, I am keeping my bets relatively small. I currently have one third of my normal position on and I am long calls.

The rally this morning should continue to grind higher. Tomorrow (expiration Friday) will be choppy and traders will “square up”. Passive accounts can wait for the actual outcome and take bullish positions Monday. The market will gap up on the news, but the move should be sustained. I will be watching yields in Spain and Italy. If they pull back on the news, the rally will have “legs”.

I suggest taking bullish positions ahead of the weekend. I would not sell put spreads. An anti-bailout victory would spell disaster for the market and you will not be properly rewarded for the risk you are taking.

Be prudent and know that risk levels are elevated.
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